Canada's Pensions Staying The Course?

Mark Machin, President & CEO of CPP Investments, updated Canadians telling them to take comfort, the CPP Fund is built for the long haul:
As the head of CPP Investments, the organization that invests the Canada Pension Plan Fund in the best interests of millions of Canadians, I spend a lot of my time thinking about long-term risks that could affect the safety of our investments, risk in relation to opportunity, and the potential risks we can’t foresee that spring up suddenly.

The COVID-19 pandemic currently roiling markets worldwide falls squarely in that last category. While the possibility for widespread contagion is ever present, a few short months ago it was still a theoretical risk. No longer.

This coronavirus presents a serious challenge to communities and people everywhere and is forcing profound changes in our daily lives.

At CPP Investments, we’re taking all precautions to prevent community spread and are encouraging others to do the same. We’ve stopped all non-essential travel, enabled our employees to work from home, and are doing our part to maintain essential services to Canadians.

For us, that means continuing to help protect the Canada Pension Plan, which is the base layer of retirement savings for most Canadians. Canadians are focused, as they should be, on keeping their families healthy. We remain focused on safeguarding the financial health of the CPP Fund. I can assure you that, even in the aftermath of the stock market declines in recent days, the sustainability of your CPP Fund remains secure.

In the coming months, many businesses, will experience levels of stress they have not seen in years – or in fact, may have never seen. We take a long-term view. We have weathered crises before, and we know that heightened stress makes it ever more important to keep our focus on the long term.

Our job is to deliver strong financial performance for multiple generations. That’s why we evaluate every investment we make on its ability to generate returns for decades, not on the likelihood of an up or down price movement in the next quarter.

Of course, we will continue to stress test our portfolio, looking at investment outcomes under a variety of extreme scenarios so we can be confident that, whatever happens over the coming weeks and months, the necessary funds will always be available for CPP benefits payments.

With this long-term view, we pursue an active, long-term investing strategy. Starting most crucially with diversification, both in where and how we invest. We invest across sectors, strategies and markets that span the globe. This diversification ensures our access to the best opportunities, reduces risk from overexposure to any one market or asset class, and lets us buy and hold when others can be distracted by short-term volatility.

Another critical strength is our size, soundness and governance structure, which allows us to navigate market volatility unlike many other investors. We’ve weathered through trouble before, not allowing short-term drops to distract us from focusing on long-term gains. During the Global Financial Crisis, the CPP Fund lost 18.8% in value in one year, but just six years later the CPP Fund’s investments gained 18.3% in one year alone. What matters is our performance over a much longer horizon. Our 10-year performance, reported in December, was well over 10%.

Over the past 21 years, we’ve grown the CPP Fund from $36.9 billion to $420.4 billion; and the most recent report by the Chief Actuary of Canada, released in December 2019, states the Fund continues to be sustainable for more than 75 years. This performance was made possible by the diverse skills, deep expertise, and network of relationships we’ve built over the years.

We don’t yet know the full impact of COVID-19. It will continue to affect the global economy and like other global investors, we will not be immune. We believe strongly, however, that our long-term investing view, our deep bench of talent and expertise, and our highly-diversified portfolio will continue to serve the Canadians who depend on us for the safety of their retirements. To all 20 million Canadians who participate in the CPP – it is with kindness to one another and confidence in the systems in place, like the CPP, that we will endure.
Dr. Mark Machin tells it like it is and he's spot on, the CPP Fund isn't immune to the downturn -- no pension is -- but it has the right governance and long-term view to invest across public and private markets all over the world, and it will weather this storm as it has weathered previous ones.

I'm not too worried about Canada's large pensions, not only to they have the right governance, long-term focus and skill set to weather this crisis, they also have great balance sheets and can leverage up their portfolios to take advantage of dislocations in the markets.

Yesterday, I had a chat with HOOPP's soon-to-be retired CEO Jim Keohane on that organization's stellar 2019 results. Jim told me they got hit this quarter but their surplus allows them to absorb these losses and they remain full funded.

He also told me they are holding daily management meetings to discuss dislocations in markets and where to take risks to obtain the best risk-adjusted returns.

I guarantee you the same thing is happening at all of Canada's large pensions which are all liquidity providers.

Yaelle Gang of the Canadian Investment Review reports on how OPTrust's CIO, James Davis is keeping calm and sticking to the plan:
Although the markets are changing quickly due to the impacts of coronavirus, the OPSEU Pension Trust is a long-term investor and its overall investment strategy hasn’t changed, says James Davis, the fund’s chief investment officer.

The plan’s portfolio was constructed to be resilient and withstand events similar to what’s happening in today’s markets, he says, noting the portfolio is broken down into three sections: risk mitigation, return seeking and liability hedging.

“The liability-hedge portfolio, which is comprised mostly of bonds is doing very well,” says Davis. “The risk-mitigation portfolio is doing even better because there we’ve got exposure not only to bonds but to [trend strategies] and also to defensive currencies and we have some gold in that portfolio as well . . .The return-seeking portfolio, on the other hand, of course, has more exposure to risk. You need to take that exposure to risk in order to earn the returns to pay pensions. And that is the part of the portfolio that is experiencing drawdown at the moment.”

That said, since the OPTrust is a relatively mature pension plan, its portfolio has been designed with the objective of earning the return required to pay pensions at the lowest risk possible, so its risk exposure is low.

However, while the plan is in a good position, some worrisome things are playing out in the market, he adds, noting correlations that are a reflection of illiquidity.

“The markets, at this point in time, are experiencing something not dissimilar to 2008, and central bankers are doing what they can to unclog the plumbing. But I think that, coupled with a lot of quantitative strategies that are essentially position-sized on the basis of volatility, as volatility has risen, they’ve had to unwind some of those positions and that has added to the illiquidity in the market because there’s simply not enough buyers and too many sellers.”

The OPTrust, in particular, is quite flush with liquidity because it set its investment strategy up with this in mind. “Now, with markets in the state that they’re in, opportunities are presenting themselves on a daily basis and we have the ability to provide liquidity to the markets and take advantage of some of those opportunities.”

But Davis does acknowledge that the plan isn’t a market-timer, adding he doesn’t know when the bottom will be hit. “We’ve looked at bear markets since 1900 and what we’ve seen now is not as bad as it can be and it’s certainly too short to call an end to it. So we have to be mindful that this can get worse before it gets better.”

At times like this, it’s important for plan sponsors to stay focused on the amount of risk they’re taking and avoid excessive risk, says Davis, though with interest rates falling over the last several years, central banks have been pushing investors out on the risk curve.

As a result, investors have used leverage to achieve higher rates of return because risk premia have been relatively low.

“I think that’s what’s causing some of the stress in the markets, but I believe being a long-term investor puts us in a really good position,” he says. “And being able to think long term like pension plans can and being able to provide liquidity to the market is a real advantage. That’s really what the Canadian model has been able to do over the past couple of decades.”
Canada's large liquidity providers are all thinking the same way: where do we put money at risk to generate the best risk-adjusted returns over the long run?

And there are endless opportunities out there right now: corporate bonds, European banks, emerging markets, etc.

As far as the bottom, the man who scored big during the 2008 crisis came out this morning stating the stock market could be near a bottom:

And we know how the day ended, the Dow rebounded more than 11% in its best day since 1933 as Congress nears coronavirus stimulus deal:

Is this "the" bottom everyone has been waiting for? Nobody knows, it could be a massive short squeeze giving the bears plenty of ammunition to pounce again.

But I was talking to two smart hedge fund managers earlier today who told me "the amount of fiscal and monetary stimulus going on all over the world is unprecedented" and it's hard to imagine we won't bounce back strong.

Still, I warn you, it's early innings for us in North America and while Trump wants to restart the economy ASAP, others think he's dreaming:

Pay close attention to Bill Gates, he has been warning the world that it's not ready for the next pandemic for years, and he's spot on when he states this:
“It’s very tough to say to people, ‘Hey keep going to restaurants, go buy new houses, ignore that pile of bodies over in the corner, we want you to keep spending because there’s some politician that thinks GDP growth is what counts,’” Gates said. “It’s hard to tell people during an epidemic … that they should go about things knowing their activity is spreading this disease.”
What else? An FT article came out highlighting an Oxford study stating half the UK population may be infected with coronavirus:

Here's is what a friend of mine, an expert physician in the US, shared with me on this article:
This could be true but it doesn’t change the fact that the hospital systems were overwhelmed in China and Italy because a much larger fraction of cases (10% ) than the flu need hospitalization across the age spectrum (it’s not just the mortality rate) and from those that need hospitalization because they need oxygen, you have no idea who will progress to death vs improve.

If this is true, the good news is that after a few months a large fraction of the population will be immune (i.e. the herd immunity) but you still have to go through a lot of pain in the first few months and flattening the curve makes the most sense to give everyone a chance at a ventilator. I think the authors acknowledge this.

No proof until large scale serologic studies are completed.

Stay safe.
That's my advice to everyone, stay safe, we need to accept this new reality for at least six to nine weeks and probably longer.

Below, Mark Machin, President & CEO of Canada Pension Plan Investment Board and FCLTGlobal Board Member, discusses how to align asset owners and asset managers for the long term by optimizing investment mandates (2018).

More recently, FCLTGlobal is developing practical tools to address the issue of balancing long- and short-term risks. Hear from their members on how they assess, manage, and plan for investment risk.